GeoResources A More Obscure Play On Well-Known Formations

Almost anyone who pays attention to the oil and gas space is familiar with the robust growth in activity in the Eagle Ford and Bakken regions of the U.S. Companies like Chesapeake Energy (NYSE:CHK), Anadarko (NYSE:APC) and EOG (NYSE:EOG) are major names in the Eagle Ford, while Continental (NYSE:CLR) and Kodiak Oil & Gas (NYSE:KOG) attract a lot of attention for their Bakken assets.

Amidst this, GeoResources (Nasdaq:GEOI) is a relatively lesser known name. Although it's not exactly undiscovered (about 14 sell side analysts cover it and over 75% of shares are owned by institutions), the relative valuation of other smaller Bakken/Eagle Ford plays suggests investors are not fully onboard the story just yet.

Growth Today, Growth TomorrowOutside of some legacy assets in the Gulf Coast and Southwest regions, GeoResources is a story focused on two of the fastest-growing energy producing areas of the U.S. - the Bakken in North Dakota and Montana, and the Eagle Ford in South Texas. Though a substantial portion of the company's production in 2011 still came from the legacy regions (about one-third), the company has openly talked about selling these assets to free up capital to further exploit its Eagle Ford and Bakken opportunities.

With ongoing development in the growth regions, GeoResources saw better than 20% growth in proven reserves in 2011, with the percentage of oil jumping up to 67%. Finding and development costs were relatively attractive (below $17/BOE), and there is at least a chance that the company could ultimately triple this reserve base if development activities go well.

Working Its InterestsOne of the drawbacks to the GeoResources story for some investors is the significant impact of working interests in the company's production and development plans. It is relatively common for exploration and production (E&P) companies to develop acreage in partnership with other companies, spreading the risk, reducing capital demands and sometimes taking advantage of other companies' experience and relationship with service providers.

In the case of GeoResources, quite a lot of production has been coming from wells where they have less than a 50% working interest (and sometimes less than 35%). While that does mean that the revenue from those wells has to be shared, the company is the operator in the majority of cases and that it gives it solid control over its fate (as much as is possibile in this industry).

It's not as though this strategy has been all bad, though. The company was in a net cash position at year's end and has $180 million in untapped borrowing capacity to fund lease acquisition and development costs. Given that more than a few E&P companies have gorged on debt, only to find themselves forced to sell or partner on unfavorable terms, this solid liquidity position is a fair trade for the drawbacks of the working interest structure.

The Bottom LineThere's no fail-safe valuation methodology for E&P companies. While many investors and analysts will attempt to construct net asset value (NAV) models that calculate the value of proven and unproven reserves, others will go with simpler methodologies like EV/EBITDA or EV/acreage. Though there is something to be said for the added rigor of a NAV model, the reality is that in many cases it simply replaces a simple guess with a more elaborate series of guesses.

To that end, I'm comfortable with EV/EBITDA analysis in the case of GeoResources. Smaller E&P companies usually trade at a range of 6 to 8 times forward EBITDA, and I believe the reserve and production growth potential for GeoResources merits a relatively healthy premium of 7.5 times. With that multiple, fair value for these shares comes in at around $42.